Today we unveil five proven tax strategies for business owners like you. As an entrepreneur, you understand that taxes can significantly impact your bottom line. That is why we empower you with invaluable insights and expert advice to optimize your tax planning and maximize your business’s financial potential. Whether you are a Startup founder, a seasoned CEO, or somewhere in between, these carefully curated strategies will help you navigate the complex world of taxation, reduce your tax burden, and keep more of your hard-earned money in your pocket. Get ready to unlock the secrets of successful tax planning and take your business to new heights of profitability and success.
Reduce Taxes By Using a Tax-Smart Investment Strategy
A corporate-class mutual fund is an investment vehicle that allows investors to invest in various assets, such as bonds, stocks, and securities. It offers tax benefits and differs from conventional mutual funds in that it is structured as a single taxable corporate entity rather than as separate trusts, which is how traditional mutual funds are structured. The fund is divided into various classes of shares, each with its own investment policies and objectives.
One of the significant benefits of investing in a corporate-class mutual fund is that it allows investors to move their money from one share class to another without triggering capital gains taxes. This feature allows investors to adjust their investment strategy without incurring additional tax obligations.
Investment companies usually offer corporate-class mutual funds to cater to investors seeking tax-efficient investment options. However, it’s essential to remember that not all investors are suitable for these funds, and investors should consider their investment objectives and risk tolerance before investing in any mutual fund.
Because Corporate class investments offer tax benefits by treating a mutual fund corporation as a single legal entity rather than taxing each individual mutual fund within the corporation separately, this approach can result in tax-efficient growth and tax-efficient cash flow, commonly referred to as “tax-smart” or “tax-efficient” benefits. It can allow investors to structure their investments to maximize the potential for tax savings.
Tax-efficient growth is achieved by pooling the income and expenses of all the different mutual fund classes within the corporation. Corporate class funds can share income, gains, losses, expenses, and loss carry-forwards to reduce the corporation’s taxable distributions. Distributions tend to be more tax-efficient than those from traditional mutual funds because corporate-class funds can only distribute Canadian dividends and capital gains dividends, which are taxed more favourably than regular income.
Additionally, corporate class funds cannot distribute interest or foreign income retained within the corporation and are subject to taxation unless offset by expenses. By minimizing or deferring taxes, investors can benefit from compound growth and potentially save more money than if they held a conventional balanced mutual fund that pays taxable interest and foreign income.
By combining corporate-class investments with T-class investments, tax-efficient cash flow can be achieved. T-class refers to a specific share class of mutual funds that are designed to be tax-efficient. T-Class funds provide cash flow by returning an investor’s original investment principal in a return of capital, which is not taxable because the investor already paid tax on it before investing. A return of capital reduces the adjusted cost base (ACB) of class fund shares held. Once an investor’s entire capital has been returned, subsequent cash flows are treated as capital gains and taxed at a favourable rate. This allows investors to receive tax-efficient cash flow without selling their investments and deferring capital gains.
Overall, corporate-class investments provide a tax-efficient way to organize investments and potentially save on taxes. By pooling income and expenses and offering tax-smart cash flow options, investors can benefit from reduced taxes, leaving more money in their accounts to benefit from compound growth. However, it’s important to note that these benefits may not apply in all situations. Investors should consider their specific tax circumstances and investment goals before investing in any mutual fund. If you have any questions, contact your Mutual Fund Dealer regarding Corporate Class and how it works. You should also consider working with a financial planner if you are not currently working with one to apply tax-efficient strategies to your situation and stay informed about all the Tax-saving tips.
Unlimited TFSA
The Unlimited TFSA strategy is tax-efficient for business owners and individuals to maximize their savings and investments. This strategy involves investing in tax-exempt Permanent Cash Value Life Insurance, which allows investors to grow tax-exempt savings and access them during their lifetime without incurring taxes. This approach also enables individuals to pass their savings virtually tax-exempt to their families, making it a great way to build and protect wealth for future generations.
One of the primary advantages of this strategy is that it provides a way to invest beyond the contribution limits of a traditional Tax-Free Savings Account (TFSA). With a TFSA, contributions are limited to a set amount each year, and any contributions beyond that limit are subject to taxes. In contrast, tax-exempt Permanent Cash Value Life Insurance allows individuals to invest as much as they want without any upper limit, enabling them to grow their savings tax-free.
Another advantage of this strategy is that the savings component of the life insurance policy, known as the cash surrender value (CSV), grows tax-exempt. This means that investors can accumulate funds that can be accessed during their lifetime if needed for emergencies, investment opportunities, or to supplement their retirement income. Additionally, the death benefit proceeds payable at death are tax-free if the policy is owned personally or with little tax if owned corporately, making it a great way to protect wealth for future generations.
Overall, the Unlimited TFSA strategy effectively allows investors to build and protect their wealth while minimizing taxes. By investing in tax-exempt Permanent Cash Value Life Insurance, individuals can maximize their savings and investments while enjoying the benefits of tax-free growth and access to funds during their lifetime, as well as the ability to pass along their savings virtually tax-free to their loved ones.
The Business Owner’s Pension Plan
Individual Pension Plans (IPPs): What You Need to Know
Retirement planning can be complex, especially for those with high incomes or self-employed individuals. One potential option to consider is an Individual Pension Plan (IPP).
What are Individual Pension Plans?
An IPP is a defined benefit pension plan that an individual rather than an employer establishes. This means that the individual contributes to the plan, and the plan promises to provide a specific retirement benefit based on the contributions made and investment returns earned. IPPs are designed to provide retirement income for the individual and potentially provide some tax advantages.
How do IPPs work?
IPPs are typically set up by a corporation owned by the individual or by the individual themselves if they are self-employed. Contributions to an IPP are tax-deductible for the corporation or individual making the contributions up to a specified limit based on the individual’s age and income. The contributions are invested by the IPP in a mix of investments, such as stocks, bonds, and real estate, to generate returns that will be sufficient to fund the promised retirement benefit.
The amount of the retirement benefit provided by the IPP is determined by a formula based on the individual’s age, years of service, and contributions to the plan. Once the individual reaches retirement age, they can begin receiving a monthly pension payment from the plan.
Who is eligible for an IPP?
Only some people are eligible to establish an IPP. In general, an IPP may be a good fit for individuals who meet the following criteria:
- They are at least 40 years old
- They have a history of T4 income or earnings from self-employment
- They have a desire to save more for retirement than is allowed by other tax-deferred retirement savings plans, such as RRSPs and TFSAs
- They have a stable source of income and expect to remain in their profession or business for many years to come
Pros and cons of an IPP
Like any retirement savings plan, IPPs have both advantages and disadvantages. Some potential advantages of an IPP include:
- Higher contribution limits than other retirement savings plans
- Potential tax savings, as contributions are tax-deductible and investment earnings grow tax-free until retirement
- A defined benefit pension, which provides a guaranteed retirement income for life
- The ability to transfer assets to a spouse or other beneficiary in the event of the individual’s death
Some potential disadvantages of an IPP include:
- Administrative costs associated with establishing and maintaining the plan
- The potential for investment losses that may reduce the value of the retirement benefit
- The requirement to make regular contributions to the plan, which may be difficult for individuals with fluctuating income
- The need to adhere to certain regulatory requirements, such as annual actuarial valuations and funding obligations
Comparison with other retirement savings options
IPPs are just one of many retirement savings options available to individuals. Other options, such as RRSPs and TFSAs, may also be suitable for some individuals. Some of the unique advantages and disadvantages of each option include:
- RRSPs: Contributions are tax-deductible, but withdrawals are subject to income tax. Contribution limits are lower than for IPPs, but RRSPs are more flexible in terms of contributions and withdrawals.
- TFSAs: Contributions are not tax-deductible, but investment earnings grow tax-free and withdrawals are tax-free. Contribution limits are lower than for IPPs, but TFSAs are more flexible in terms of withdrawals.
In conclusion, Individual Pension Plans (IPPs) can be a powerful retirement savings option for high-income individuals or self-employed individuals looking to save more for retirement than other retirement savings plans allow. While IPPs have some unique advantages, such as higher contribution limits and potential tax savings, they also come with some potential disadvantages, such as administrative costs and investment risks.
Nonetheless, As a business owner or incorporated professional, it may be worth considering an Individual Pension Plan (IPP) instead of relying solely on an RRSP. An IPP’s benefits include saving more than the limits set by RRSP rules – up to 65% more – based on your T4 income and years of service. Additionally, an IPP can provide tax savings and increased creditor protection. With an IPP, you can determine precisely how much you will receive each year through its defined benefit component, or you can choose the defined contribution path to determine how much you will contribute annually.
If you are considering an IPP, it is important to weigh the pros and cons carefully and to work with a financial advisor and/or tax professional to ensure that an IPP is the right choice for your specific retirement planning needs. Other retirement savings options, such as RRSPs and TFSAs, may also be suitable alternatives depending on your circumstances. Ultimately, the most important thing is to have a solid retirement plan in place, regardless of which savings options you choose.
Estate Freeze
If you, like many people, decide to transfer your business to your family in a few years, or if you think you will sell in the future, you should strongly consider an estate freeze. Generally, an estate freeze is a way by which you freeze the current value of your corporation and transfer all the company’s future growth to your family members. This is a very complex topic worthy of its own book, so I will not go into the details of how they work or the tax rules that govern these situations. The most common form in which you will see an estate freeze is usually where you set up a holding company and a family trust.
See the example below:
- Parent owns all common shares of the Parent Corp; invested $1000, value of the corporation is $15 million;
- Parent expects an increase in the value of the corporation over the next several years;
- Parent exchanges his common shares in Parent Corp. for
- $15 million of new preferred shares;
- The preferred shares are voting, retractable anytime at her option. Voting shares means she keeps control of the corporation;
- Each child of the Parent then subscribes for 100 new shares in Parent Corp. and pays $1 per share. Parent Corp. is worth 15 million and the Parent shares are retractable so the common shares are negligible.
- Over the next few years, the value of Parent Corp. increases to $20 million. Parent’s preferred shares are worth $15 million, but the common shares are now worth $20 million.
- Parent has transferred the growth of the corporation to his children, who now own the common shares.
After the estate freeze has taken place, then you can receive income from the corporation either through declaring dividends on the preferred shares that you own, or through a salary if you are still active in the business. If the common shares were acquired through a trust, that will provide you with a lot of
flexibility for allocating the shares among the children. However, it would be best if you considered the tax on split income where the shares are held in trust. Additionally, when setting up an estate freeze, you may want to trigger some of the capital gain in the shares to use your lifetime capital gains exemption.
An advantage of the estate freeze is that you may be able to achieve income splitting with your family in certain situations. Still, you must also consider any attribution rules that may lead to taxation.
As I wrote before, there are whole books written on estate freezes so I will not begin to get into the details of how it works. However, as a business owner who owns a corporation, if you have value in your business that you want to pass on to your children, it is something to strongly consider with the advice and support of your advisors, planners, accountants, lawyers etc.
Virtual real estate
Many people with real estate portfolios of millions feel quite confident in their financial futures. However, they don’t realize their millions may decrease significantly once the estate taxes are paid. If you have a $40 million real estate portfolio that initially cost $10 million, you are ‘pregnant’ with a $30 million gain that will be subject to a tax of 27% (in Ontario). At death, your estate must come up with approximately $8.1 million to pay those taxes.
Make It a Strategy, not a Tragedy. There are, thankfully, a few options available to pay those taxes.
Option 1: Use cash. Even the wealthiest people I know don’t keep millions sitting around in cash, not invested, unused, and not making anyone any money. In real estate, for example, those who are most successful have an asset, grow the equity of that asset and then refinance it to buy more real estate. The same goes for those owning business/private equity.
Option 2: Borrow. Who would your family borrow from, and what will the interest rate be? That interest expense will not be tax deductible. Of course, the debt must eventually be repaid, and no one can accurately predict market conditions.
Option 3: Sell the real estate, sell the business, or liquidate other assets. While I say that’s an option, it’s more tragedy than strategy if your family must go that far. Even if that drastic measure is a possible way of dealing with the tax issue, what kind of real estate will they sell? Will it be a good time to sell? Will your business be worth 100 cents on the dollar if you are not around? The whole idea of this option is so antithetical to how you have been investing in real estate or your business. Selling your business or real estate to fund a tax liability is like selling the cow that’s been producing milk for you for years.
Option 4: This method is likely the least expensive way of handling the issue: using tax-exempt life insurance. Now don’t be put off by the fact that it’s insurance. You may be like many people who see insurance as a kind of “grudge” purchase, like paying the premiums on a car or home insurance; they feel forced to do it and feel they rarely receive anything for it. Those people know what life insurance is, but no one has explained what it can do.
In this case, we are talking about using permanent insurance, which can become an asset rather than an expense. Real estate investors can use the embedded cash surrender value of their permanent insurance as collateral to borrow against and use the proceeds to invest in more real estate or their business., When doing so, they can often deduct the interest costs. As you know, few tax-exempt products are left in Canada – your personal residence, lottery winnings (good luck), TFSA, and life insurance.
Please know that the insurance we’re discussing here is not term insurance that increases in cost every 10 or 20 years and eventually expires. Term insurance is like renting a home or an apartment: you get the use of it while you pay and live there but once you leave, you have no equity to take with you. There are two major components of permanent life insurance. There is, of course, the death benefit, which in real estate parlance, can be considered the future “market value.” There is also the cash surrender value that we can equate with the current “equity” value. Over time, contributing to an insurance policy builds up your policy’s cash value.
Many people see insurance as a “grudge” purchase, but permanent life insurance can become an asset rather than an expense. Real estate investors can use the cash surrender value of their permanent insurance as collateral to borrow against and invest in more real estate or their business while also being able to deduct the interest costs. Permanent life insurance has two major components: the death benefit and the cash surrender value, which builds up over time and can be compared to equity value in real estate.
Tax-exempt life insurance is a strategic option for managing estate taxes because it can provide liquidity to pay taxes while preserving the family’s assets. This approach can benefit individuals with large real estate or business holdings.
Moreover, life insurance offers many other benefits beyond paying estate taxes. It can provide income replacement for surviving family members, help fund a business succession plan, and leave a legacy for future generations. Permanent life insurance also has the potential to accumulate tax-free cash value, which can be used for various purposes such as funding retirement, paying for college, or making a large purchase.
When considering life insurance as a strategy for estate planning, it’s essential to work with a knowledgeable advisor who can help you determine the right type and amount of coverage. There are various types of permanent life insurance policies, including whole life, universal life, and variable life, each with its unique features and benefits.
Bonus:
Corporate Debt Swap
A corporate debt swap is a financial strategy where an individual or a corporation restructures their debt to take advantage of tax deductions on interest costs. For example, Peter has $150,000 in debt but cannot deduct its interest. However, he does have cash or investments that he can utilize.
Peter employs a debt swap strategy to claim a deduction for his interest costs. First, he uses his available cash or sells his investments to generate cash. With this cash, he pays down his existing non-deductible debt. By reducing his non-deductible debt, Peter can replace it with new debt eligible for the interest deduction.
After paying down the debt, Peter borrows funds to replace his used cash or investments. This new debt is carefully structured to meet the criteria for interest deduction. The key factor is that the borrowed funds are directly tied to an income-producing purpose. As long as Peter can trace the borrowed funds to generate income, he becomes eligible to deduct the interest costs on the new debt.
In summary, a corporate debt swap involves using available cash or liquidating investments to pay down non-deductible debt, followed by borrowing funds to replace the cash or investments used. The individual or corporation can claim deductions on the interest costs associated with the new debt by ensuring that the borrowed funds are linked to income-producing activities, such as investments or business operations.
